A less violent reinsurance cycle, thanks to patient alternative capital

Senior reinsurance industry executives said that the market cycle is likely to be less “violent” going forwards, with fewer radical price movements as the industry matures and “patient” alternative capital helps to smooth our the peaks and troughs.
RenaissanceRe’s CEO Kevin O’Donnell said recently at the 2017 Bermuda Reinsurance Conference held by S&P Global Ratings and PwC Bermuda that he sees alternative capital as “more patient than cheap.”

At a time when the reinsurance sector faces enormous losses and the ILS market has suffered its largest losses ever, this patience could prove vital to the future stability of the market.

In the past we could have expected rate increases of as much as 70%, following hurricanes causing losses of the magnitude of Harvey, Irma and Maria. After the 2005 hurricane year, when Katrina, Rita and Wilma struck the United States, the Guy Carpenter U.S. Property Rate on Line Index jumped by 76%, reflecting steep price increases as reinsurers looked to secure payback.

But price rises of this magnitude are unlikely now, despite the fact that Harvey, Irma and Maria could cause a larger industry loss than KRW in 2005. Both the maturity of the market and the staying-power of alternative capital investors are key to this, helping to bring greater stability to pricing, ultimately to the benefit of the insurance policyholder.

“I think we are moving to a more mature industry, and there will continue to be a secular shift toward efficiency and more stable margins,” O’Donnell suggested.

He hit on the heart of the issue with his following statement, saying, “What we need to get to is some oscillation around a price that is the right price for the risk we are assuming.”

This is absolutely key, that the reinsurance industry can find a way to price risk accurately, allowing supply, demand, margin and risk-related factors to influence pricing up and down from that point.

This would naturally result in a much narrower spread between the top and bottom of the reinsurance price cycle, as well as offering buyers greater transparency.

“We’re going to start to be more precise over time, or else the market makes no sense. It can’t play the way it did, it just won’t,” he continued.

The executives cited alternative capital and the ILS investors who now augment the overall reinsurance market with their capacity as a complementary source and one that is here to stay.

“I’d rather be in a marketplace that is attractive to capital than not,” McGavick said. “And people tend to talk a little sloppily about what alternative capital is. The front end of alternative capital is still traditional underwriting, it’s the pooling of risk.”

“We believe that it will be here in the long-term,” agreed RenaissanceRe’s O’Donnell. “People think of this as some sort of monolithic capital that comes in or out, but all capital has different appetites. Alternative capital is more patient than cheap.”

This patience could be rewarded at the next few reinsurance renewals, particularly if the price cycle is much less violent and the movements less radical.

ILS and alternative capital may have an opportunity to demonstrate just how complementary it can be, especially if price swings are not as radical as some traditional players would have liked.

If the industry is indeed to return to more stable margins, as O’Donnell suggests, it may be necessary for reinsurers to offload higher volatility exposures onto a third-party balance-sheet, as their own capital may not be able to absorb them as well, especially if the more stable price level is not as high as they would have liked.